How Tax Reform Now Affects Divorce Settlements

More than a year after it was signed into law, some provisions of the Tax Cuts and Jobs Act are still starting to come to light. For example, the legislation made significant changes to the taxation of alimony payments starting this year that some experts say could have a major impact on divorce in this country.

Wide-Ranging Effects

The change is relatively simple, but the effects could be wide-ranging. Previously, alimony payments were deductible by the spouse making payments, while the spouse receiving alimony payed income taxes at his or her ordinary income tax rate.

For divorces that occur after December 31, 2018, alimony payments will no longer be tax-deductible. Also, the spouse receiving alimony will no longer be taxed on the payments, and legal fees paid to divorce attorneys are no longer deductible.

So why was this change in the taxation of alimony payments made? Mainly in order to raise federal tax revenue. It’s estimated that the change will result in an additional $6.9 billion in revenue for the federal government over the next decade.

A “Divorce Subsidy”

Experts say one reason alimony payments had been deductible was to serve as a “divorce subsidy” by giving higher-earning divorcing spouses a financial incentive to make these payments. Assuming the spouse receiving payments was the lower-earning spouse, he or she may have been in a lower tax bracket and thus paid less tax. The result was a bigger pot of money available to both ex-spouses and their children.

The divorce subsidy also prevented some divorces from going to trial, especially ones that were financially contentious. Members of the American Academy of Matrimonial Lawyers are almost unanimous (95 percent) in their belief that this change in the taxation of alimony is going to change how most divorces in the U.S. are settled.

Most divorce lawyers (64 percent) also believe that the change will result in more acrimonious divorces by discouraging higher-earning spouses from paying alimony and child support, which is often determined along with alimony during a divorce settlement.

As a result, divorces could also become more expensive. Couples that go to trial spend an average of $19,600 on a divorce, which includes $15,800 in attorney’s fees, according to Nolo.com. But couples that settle without going to trial spend an average of $14,500 on a divorce, which includes $12,200 in attorney’s fees.

Of course, there’s also the non-financial cost of a nasty and contentious divorce. Divorces that go to trial and drag on for weeks or months can take an emotional toll on the spouses as well as their children.

Who’s Better Off?

At first glance, it would appear that spouses receiving alimony will be better off financially, since they will no longer have to pay tax on this income. But some experts say that lower-earning spouses may actually end up receiving less financial support in the long run because the overall amount of money will be less — not to mention the fact that higher-earning spouses may fight harder to reduce the amount of alimony they have to pay.

Couples who were divorced before this year are grandfathered into the old rules governing taxation of alimony payments. If modifications are made to an existing divorce settlement, however, the new settlement could be subject to the new rules.

The new rules could also affect existing pre- and post-nuptial agreements, so these should be carefully reviewed by an experienced financial advisor and/or divorce attorney.

Expert Assistance is Critical

Given these new alimony taxation rules, it’s critical to obtain expert financial and legal advice before beginning divorce proceedings. Please contact us if you have any questions about the new rules and how they could affect an upcoming divorce or an existing divorce settlement.

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